21 Strategies for Creating an Emergency Fund, and Why It’s Critical

Every Tuesday is Finance & Family Day at Zen Habits.

Building up an emergency fund, if you haven’t already, is one of the most important things you can do to help your finances.

But you knew that.

It’s common financial advice, actually, but what’s not so common is how to actually do it. Obviously those who haven’t saved up an emergency fund have a difficult time saving money, even if they know they should.

So today we’ll look at some strategies for building up an emergency fund, for those of us who don’t have it so easy.

Why It’s So Critical
I don’t like to use the word “critical” often, because it’s often an exaggeration. But in this case, when we’re talking about the health of your finances, an emergency fund is definitely critical.

If you are having financial problems, the most important steps you can take immediately are 1) reduce your spending by being more frugal; 2) stop getting into debt; and 3) build an emergency fund of $1,000 (and later you can increase that to the standard 3-6 months of income).

Here are a few reasons an emergency fund is critical to your financial health:

Stop getting into debt. When an emergency comes up, if you don’t have an emergency fund, the first thing that will be cut from your budget is your debt repayment. You’ll use your credit card to pay for the emergency, and then you’re deeper in the hole. An emergency fund stops the need to use credit to pay for emergency expenses.
Smooth out your budget. If unexpected things come up, you don’t have to continually re-factor your budget to pay for these things. With an emergency fund, it makes budgeting much easier.
Prevent late fees. If you are living paycheck-to-paycheck, you will come up with times when you have to pay a bill late, or overdraw your bank account. With an emergency cushion, you avoid these financial hits.
Get ahead. If you can get a month ahead, your financial stress will drop way down. Instead of always playing catch-up, you can pay your bills ahead of time and sit back and relax.

21 Strategies for Creating an Emergency Fund
If you have trouble saving, it’s not enough to tell you how important it is to have an emergency fund. You need some strategies for doing it.

Please note that you should choose the strategies that work best for you, and perhaps combine some of them if that works better.

Start small. If you don’t have much to save, it doesn’t matter — the important thing is just to start. Even if it’s only $25 per paycheck, just start. It will slowly grow each paycheck, and you will be glad to see at least a little in your savings, and will soon be motivate to try to save more.
Automatic deduction. This is common advice, but that’s because it works. Set up an online savings account (such as ING Direct or Emigrant Direct) and have it automatically deduct an amount each payday. If you don’t have to think about it, saving will be much easier.
Payroll deduction. If you have discipline problems, there are accounts where you can have the amount deducted directly from your paycheck, before it’s deposited into your checking account (or before your employer cuts the paycheck).
Treat it as a bill. Every payday, you have a list of bills to pay before you can spend any of your money on variable expenses such as gas, groceries or eating out. Well, add your emergency fund contribution to your list of bills, and pay it at the same time. This makes it non-negotiable, and then what’s left over is what you can spend on other stuff.
Reduce an expense, save it. Take a look at how you’re spending money now, and find some things that can be cut back. Magazine purchases, gourmet coffee, comic books, cable TV, gizmos and gadgets. Whatever you decide to cut back on, take that same amount and put it directly into savings each paycheck. Don’t spend it.
Round up. I got this tip from J.D. Roth of Get Rich Slowly … actually, it’s a strategy used by his wife, who will log every purchase or check she writes into her checkbook or finance software — but rounds up to the nearest dollar. So if she spends $26.01, she enters it as $27. Over the course of a month, this can add up to decent savings.
Double purpose account. This tip is from Trent of The Simple Dollar, who wanted to pay down his debts but still have the financial security of an emergency fund at the same time. So Trent brilliantly used a double-purpose account: he would save money in an account, and after he reached a certain minimum, anything above that amount was being saved to pay off a specific debt. So let’s say the minimum amount is $500. After you pass $500, the money being saved is for a $200 debt (for example). Once you reach $700 in your savings account, you can pay off the $200 debt completely. Repeat the process for each debt.
Tip yourself. If you go to a restaurant and tip a waiter 15 or 20 percent, for example, match that tip for yourself. So if your tip is $10, tip yourself $10 as well … and put that directly in savings.
Keep paying debt, but to yourself. If you finish making a car payment, or paying off a credit card or smaller debt, take the amount you were paying to that debt and put it directly in savings each month. You won’t feel a difference in your budget.
Budget big for groceries, then save the difference. Let’s say you normally spend between $320 and $375 on groceries. Budget $400 for groceries, and whatever you don’t spend of that $400, put it in savings.
Quit smoking or drinking. Well, I wouldn’t bet my emergency fund on quitting one of these two addictions, but if you do quit, you should take the amount you were spending (and that’s a considerable amount, I know) and put it into savings. For me, I spent more than $5 a day on smoking — and when I quit in November 2005, it freed up $150 a month for savings.
Limit your access. If you are tempted to spend your savings, you should put it in an account that is hard to get to. Put your savings in a money market account or fund, and when it reaches a certain amount, roll it over into a CD or Treasury bond. You might not make as much on a CD, for example, but the point is that it’s hard to access and requires less discipline.
Stash a bonus or tax refund. If you get a Christmas bonus, or a tax refund, or some other such windfall, put that directly in the bank and don’t spend it. Use it for your emergency fund. Now start paying off your debt.
Save your change. Don’t spend any coins you get. When you get home at the end of the day, empty out your pockets into a jar, and once a month, go to the bank and put it into savings. This can add up faster than you think.
Save dollar bills. Similar to the above strategy, get your cash in $20 bills, or $10s or $5s. Don’t carry $1 bills. When you get $1 bills as change, don’t spend them. When you get home, put those $1 bills in an envelope, and save them.
Refinance. Refinancing your mortgage or auto loan can save you a lot of money. Take the amount you save and put it in savings.
Sell your car. If you have two cars, see if you can live without one of them. That’s what my wife and I do, and it works out fine, even with six kids. Take the amount you were paying on the second car and save it. Or, alternatively, sell your car and buy a cheaper used model. Save the difference in the payments.
Cut out dessert. If you’re trying to lose weight, don’t order the dessert or junk food you would normally order. Instead, put the amount you would have spent in an envelope and save it.
Stay in. Instead of going to the movies or eating out, cook your own meals and watch a DVD — or do something fun for free. Save the difference.
Freelance. Take your skills and market them as a freelancer, or get a second job on the side. Take the extra income and bank it. This was one of my strategies, and it works great.
Save on auto insurance. If you can switch to liability insurance, you might be able to save hundreds of dollars. Take the extra amount you would have paid for insurance and save it.

See also:

21 Strategies for Creating an Emergency Fund, and Why It’s Critical

Every Tuesday is Finance & Family Day at Zen Habits.

Building up an emergency fund, if you haven’t already, is one of the most important things you can do to help your finances.

But you knew that.

So today we’ll look at some strategies for building up an emergency fund, for those of us who don’t have it so easy.

Here are a few reasons an emergency fund is critical to your financial health:

Stop getting into debt. When an emergency comes up, if you don’t have an emergency fund, the first thing that will be cut from your budget is your debt repayment. You’ll use your credit card to pay for the emergency, and then you’re deeper in the hole. An emergency fund stops the need to use credit to pay for emergency expenses.
Smooth out your budget. If unexpected things come up, you don’t have to continually re-factor your budget to pay for these things. With an emergency fund, it makes budgeting much easier.
Prevent late fees. If you are living paycheck-to-paycheck, you will come up with times when you have to pay a bill late, or overdraw your bank account. With an emergency cushion, you avoid these financial hits.
Get ahead. If you can get a month ahead, your financial stress will drop way down. Instead of always playing catch-up, you can pay your bills ahead of time and sit back and relax.

21 Strategies for Creating an Emergency Fund
If you have trouble saving, it’s not enough to tell you how important it is to have an emergency fund. You need some strategies for doing it.

Please note that you should choose the strategies that work best for you, and perhaps combine some of them if that works better.

Start small. If you don’t have much to save, it doesn’t matter — the important thing is just to start. Even if it’s only $25 per paycheck, just start. It will slowly grow each paycheck, and you will be glad to see at least a little in your savings, and will soon be motivate to try to save more.
Automatic deduction. This is common advice, but that’s because it works. Set up an online savings account (such as ING Direct or Emigrant Direct) and have it automatically deduct an amount each payday. If you don’t have to think about it, saving will be much easier.
Payroll deduction. If you have discipline problems, there are accounts where you can have the amount deducted directly from your paycheck, before it’s deposited into your checking account (or before your employer cuts the paycheck).
Treat it as a bill. Every payday, you have a list of bills to pay before you can spend any of your money on variable expenses such as gas, groceries or eating out. Well, add your emergency fund contribution to your list of bills, and pay it at the same time. This makes it non-negotiable, and then what’s left over is what you can spend on other stuff.
Reduce an expense, save it. Take a look at how you’re spending money now, and find some things that can be cut back. Magazine purchases, gourmet coffee, comic books, cable TV, gizmos and gadgets. Whatever you decide to cut back on, take that same amount and put it directly into savings each paycheck. Don’t spend it.
Round up. I got this tip from J.D. Roth of Get Rich Slowly … actually, it’s a strategy used by his wife, who will log every purchase or check she writes into her checkbook or finance software — but rounds up to the nearest dollar. So if she spends $26.01, she enters it as $27. Over the course of a month, this can add up to decent savings.
Double purpose account. This tip is from Trent of The Simple Dollar, who wanted to pay down his debts but still have the financial security of an emergency fund at the same time. So Trent brilliantly used a double-purpose account: he would save money in an account, and after he reached a certain minimum, anything above that amount was being saved to pay off a specific debt. So let’s say the minimum amount is $500. After you pass $500, the money being saved is for a $200 debt (for example). Once you reach $700 in your savings account, you can pay off the $200 debt completely. Repeat the process for each debt.
Tip yourself. If you go to a restaurant and tip a waiter 15 or 20 percent, for example, match that tip for yourself. So if your tip is $10, tip yourself $10 as well … and put that directly in savings.
Keep paying debt, but to yourself. If you finish making a car payment, or paying off a credit card or smaller debt, take the amount you were paying to that debt and put it directly in savings each month. You won’t feel a difference in your budget.
Budget big for groceries, then save the difference. Let’s say you normally spend between $320 and $375 on groceries. Budget $400 for groceries, and whatever you don’t spend of that $400, put it in savings.
Quit smoking or drinking. Well, I wouldn’t bet my emergency fund on quitting one of these two addictions, but if you do quit, you should take the amount you were spending (and that’s a considerable amount, I know) and put it into savings. For me, I spent more than $5 a day on smoking — and when I quit in November 2005, it freed up $150 a month for savings.
Limit your access. If you are tempted to spend your savings, you should put it in an account that is hard to get to. Put your savings in a money market account or fund, and when it reaches a certain amount, roll it over into a CD or Treasury bond. You might not make as much on a CD, for example, but the point is that it’s hard to access and requires less discipline.
Stash a bonus or tax refund. If you get a Christmas bonus, or a tax refund, or some other such windfall, put that directly in the bank and don’t spend it. Use it for your emergency fund. Now start paying off your debt.
Save your change. Don’t spend any coins you get. When you get home at the end of the day, empty out your pockets into a jar, and once a month, go to the bank and put it into savings. This can add up faster than you think.
Save dollar bills. Similar to the above strategy, get your cash in $20 bills, or $10s or $5s. Don’t carry $1 bills. When you get $1 bills as change, don’t spend them. When you get home, put those $1 bills in an envelope, and save them.
Refinance. Refinancing your mortgage or auto loan can save you a lot of money. Take the amount you save and put it in savings.
Sell your car. If you have two cars, see if you can live without one of them. That’s what my wife and I do, and it works out fine, even with six kids. Take the amount you were paying on the second car and save it. Or, alternatively, sell your car and buy a cheaper used model. Save the difference in the payments.
Cut out dessert. If you’re trying to lose weight, don’t order the dessert or junk food you would normally order. Instead, put the amount you would have spent in an envelope and save it.
Stay in. Instead of going to the movies or eating out, cook your own meals and watch a DVD — or do something fun for free. Save the difference.
Freelance. Take your skills and market them as a freelancer, or get a second job on the side. Take the extra income and bank it. This was one of my strategies, and it works great.
Save on auto insurance. If you can switch to liability insurance, you might be able to save hundreds of dollars. Take the extra amount you would have paid for insurance and save it.

See also:

Posted on 31 July 2007 in Finance & Family |
Digg |
Del.icio.us |
Stumble |
Print

Comments (23)

John Says:

July 31st, 2007, 9:47 am

A couple little ways to help…

About the gourmet coffee. Instead of ordering caffe lattes (4$ a pop) at Starbucks, try switching to regular coffee. You can still go to Starbucks and it will only cost you around 2$ a pop. Plus its lower in calories.

When eating out, try ordering water instead of a soda or tea. This will typically save you about 2$ per meal.

OneYearGoal.com Says:

July 31st, 2007, 12:21 pm

I couldn’t agree more. Having a safety net is crucial for not getting caught with your pants down.

One Man. One Year. $100,000 online. Pants way up.
http://www.oneyeargoal.com

Modern Worker Says:

July 31st, 2007, 13:20 pm

Man, is this ever true! Emergency fund saving has “saved” my butt before.

Rolf F. Katzenberger Says:

July 31st, 2007, 13:49 pm

Suggestion #22 :-)
Since it’s “Finance & Family Day” - get your family involved. Share the goal of having an emergency fund with your loved one (and children?), and make achieving it a project for not just you alone. It both gives you a positive incentive for saving money as well as a protection against spending the money for less important stuff. And it’s a great way to teach your kids about finance, too.

The Buxr Widget Says:

July 31st, 2007, 14:22 pm

You forgot - Get Married.. This may be sexist, but most women just balance a checkbook better and more often than men.

Matthew Bodaly Says:

July 31st, 2007, 14:23 pm

I also can recommend getting a ShareBuilder (http://www.sharebuilder.com) account for online savings. It works like a money market account and/or stocks and bonds.

I have been using this for the last couple months and am getting about 4% interest

Howie Says:

August 1st, 2007, 1:54 am

Excellent strategies. Financial management is serious business. We need to be aware of the factors if we don’t want to waste our money.

Red Zinnia Says:

August 1st, 2007, 6:21 am

All of these are excellent suggestions, but the best are auto or payroll deduction. When the transfer to savings is automatic, you WILL figure out a way to make what’s left of your income be enough to get you through. And it’s amazing how quickly your savings will add up.

David Says:

August 1st, 2007, 11:06 am

This is an excellent list of very doable things! I actually started doing #8, except I think of “taxing” myself rather than tipping myself. That tax goes to my savings, and it doubles as an extra check on whether I really should be spending that money in the first place.

Amber Yount Says:

August 1st, 2007, 12:12 pm

I’ve got $1,000 in the bank for emergencies, but I’m trying to decided if I should still save more, because we have our own business and always have emergencies, ratehr than put it all towards our debts. Maybe I should put half towards debt and half towards saving?

Rob Ristroph Says:

August 1st, 2007, 18:37 pm

If you share an apartment or house with a roommate, you can save a lot of money in rent and utilities. Be sure to accurately keep track of all shared expenses, whether you use a notebook, billmonk.com, slackerfactor.com, or some other system. Do not pick a roommate who will encourage an expensive lifestyle, such a friend that you know you enjoy eating out with and drinking with.

I would also like to second the recommendation on insurance. Many people buy more insurance than they need, and much of the insurance sold today is a bad deal.

If you drive a used car that you pay off in full, you are not forced to buy full coverage insurance. The savings on that alone are enough to pay for a replacement used car every two years, and if you are careful you can make the car last much longer than that.

As your savings add up, your emergency fund will grow until you will feel confident in getting cheaper health insurance that has a higher deductable, thus saving more.

When evaluating insurance, one statistic to look up is the ratio of claims paid out to payments taken in. This should be above 1.0 + the rate of inflation. The insurance company should be able to invest the premiums, obtain a higher rate of return than you or I because of their size and extertise, and return it to the policy holders in cliams, less operating costs and a profit, of course. My understanding is that this is rare among insurance companies today.

Leo Says:

August 1st, 2007, 20:20 pm

@Amber: $1,000 as an emergency fund is an excellent start, and it allows you to start paying off your debt more once you’ve gotten to that point. However, if you can pay debt and continue to build your emergency fund, I definitely would go that way. The more you have there, the better off you’ll be.

Try Trent’s (from The Simple Dollar) idea — #8 in the list above — where you save the money in your emergency fund, and then use some of it to pay off a debt completely when you reach a certain point. That way, you’ll have a lot in the bank in case of an emergency, but you’ll still be paying off debts.

Alan Says:

August 1st, 2007, 20:54 pm

I agree with automatic deductions. It a great way of saving money. We know that easy access to our money will only give us a reason to spend it.

Abel Says:

August 2nd, 2007, 0:04 am

I couldn’t agree more. Emergency fund is important. Also, remember to save a big chunk if you receive a bonus from your boss. Don’t spend all. Excellent post, Leo.

Patrick Allmond Says:

August 2nd, 2007, 1:38 am

#4 is the absolute best one. The age old adage of pay yourself first works out the best for me. I will make other bills late rather than not pay myself. I figure I am the one that wants my money more than any of my billers. I do the same with my business account.

I’d also suggest doing it weekly and not monthly or bi-weekly. You will miss a big chunk of $200 a month. But you might not miss $50 a week or $25 on Tuesday and again on Friday.

Lavanaut Says:

August 2nd, 2007, 17:04 pm

Good advice, but:

“Stash a bonus or tax refund. If you get a Christmas bonus, or a tax refund, or some other such windfall, put that directly in the bank and don’t spend it. Use it for your emergency fund. Now start paying off your debt.”

…eh, I think this is exactly wrong. You’re paying interest on your debt, more than you’re getting paid on your savings. Take that bonus and use it to pay off your debt, THEN establish an emergency fund. If you’re $2k in debt, do you think it makes sense to have a $2k e-fund?

MDB Says:

August 3rd, 2007, 0:35 am

Its a great idea as it gives the flexiblity to stop living from paycheck to paycheck and cope with those little money emergencies. Then its time to get building those assets and look forward to a rosy future.

The future is bright… the future is Zen!!

Leo Says:

August 3rd, 2007, 1:00 am

@Lavanaut: You make a good point, but the reasoning behind building up an emergency fund of at least $1,000 before concentrating on paying debt is that if you don’t have that emergency fund, when something comes up that you MUST pay for, the first thing you’ll cut from your budget is your debt payment.

Having at least a $1,000 emergency fund smooths out your finances so that you’re able to pay down your debt. Dave Ramsey writes more about this if you want to read more.

But once you’ve got at least a small emergency fund, I agree that debt elimination should take priority.

Antoin O Lachtnain Says:

August 3rd, 2007, 8:38 am

I think it is important to remember that debt is not always a bad thing. A lot of people, especially small business people need to commit all their cash to their business. Having an emergency fund is just not a realistic thing to do in this situation. It may make more sense to commit all the cash and to build up a little debt if absolutely necessary in an emergency.

But if you are on a regular paycheque, or don’t have a business that requires cash, you are right.

Carol Says:

October 21st, 2007, 3:52 am

One of the things I do is save gold dollars. Not real gold, of course, but the golden Sacagawea and Presidential dollar coins. Whenever I have an extra dollar or two in my pocket, I buy gold dollars and add them to my “collection”. Why gold dollars? Because they are cool looking, especially when you have a lot of them, and I like them. That means that it’s harder for me to just spend them any old time, which is a problem I have with dollar bills. I like the security of having some cash savings in the house and because they are gold dollars and not dollar bills, they are harder for me to part with.

Ryan McLean Says:

April 16th, 2008, 0:04 am

This is a great post and I will now become a regular reader of your blog
Thankyou

Ryan McLean Says:

May 4th, 2008, 9:54 am

When I first read this post it was the first post I read from your blog.
Do you think it is worth daving up an emergency fund when you barely earn enough money to get by as it is?

Leo Says:

May 8th, 2008, 16:48 pm

Hi Ryan … I think if you are barely getting by, that’s even more of a reason to save an emergency fund.

I know it seems extremely difficult, but think about it: If you barely have enough for the essentials, think about what would happen if an emergency came up. Medical, car troubles, house troubles, etc … where would you get the money? You’d either not have the money or you’d go into debt.

Try some of the strategies above — it’s possible, because I’ve done it and so have others — and the cool thing is, once you have the emergency fund, you’ll start to notice lots of financial benefits and soundness of mind.